The refusal of Saudi Arabia and its OPEC allies to curb crude output in the face of plummeting prices has set the energy world on a painful course that will leave the weakest behind, from governments to wildcatters.
A grand experiment has begun, one in which the cartel of producing nations is leaving the market to decide who is strongest and how to cut as much as 2 million barrels a day of surplus supply.
Oil patch executives including billionaire Harold Hamm have vowed to drill on, asserting they can profit well below $70 a barrel, with output unlikely to fall for at least a year. Marginal producers in less profitable American shale areas, as well as countries from Iran to Russia and operations from Canada to Norway, will undergo the knife sooner, according to analyses by Wells Fargo & Co., IHS Inc. and ITG Investment Research.
“We’re in a very nerve-wracking environment right now and will be for probably the next couple of years,” Jamie Webster, senior director for global crude markets at IHS, said. “This is a different game. This isn’t just about additional barrels. This is about barrels that are going to keep coming and keep coming.”
Investors punished oil producers. Hamm’s Continental Resources Inc. fell 20 percent, the most in six years, amid a swift fall in crude to below $70 for the first time since 2010. Exxon Mobil Corp. fell 4.2 percent to close at $90.54.
A production cut by the 12-member Organization of Petroleum Exporting Countries would have been the quickest way to tighten the world’s oil supplies and boost prices. In the United States, supply is expected either to remain flat or rise by nearly 1 million barrels a day next year, according to the Paris-based International Energy Agency and ITG.
That’s because only about 4 percent of shale production needs $80 or more to be profitable. Most drilling in the Bakken formation, one of the main drivers of shale oil output, returns cash at or below $42 a barrel, the IEA estimates.
Many expect reductions of American output to occur slowly because of a backlog of wells that have been drilled and aren’t yet producing and financial cushioning from the practice of hedging, in which producers locked in higher prices to protect against market volatility, according to an Oct. 20 analysis by Citigroup Inc.
With a sustained price drop to $60 a barrel, shale drilling would meet significant challenges, according to Citigroup and ITG, especially in emerging fields in Ohio and Louisiana, where producers have less practice. ITG estimates it will take six months before lower prices slow production growth from American shale, which is responsible for propelling the country’s production to its highest in more than three decades.
The market pressure will hit shale companies in different ways. Many have spent years honing their operations to pull the most oil out of every well at the lowest cost, a process that can be as much art as science at the nexus of geology, engineering and infrastructure. That experience means some producers, such as EOG Resources Inc. and ConocoPhillips, can turn a profit at $50 a barrel.
The idea that lower prices will pressure shale producers to produce less oil is “a fundamental error,” said Paul Stevens, a distinguished fellow at Chatham House in London. “Such thinking has focused on how much it costs to drill new wells in new fields,” he said. “But what really matters is the price at which it is no longer economic to produce from existing fields, and that is very much lower.”
Plunging oil markets have begun to pressure governments that rely on higher prices to finance their budgets and expand drilling. Venezuela’s oil income has fallen by 35 percent, President Nicolas Maduro said on state television Nov. 19.